Beyond the crisis: Shifting gears

The deep scars of the crisis can be relieved through appropriate policy action, particularly in competition, jobs, taxes and financial services. This would bolster long-term growth too.

OECD countries seem poised for a fragile, yet much-welcome recovery. This prospect was far from certain a year ago and owes a great deal to the exceptional monetary, fiscal and financial policies that policymakers across the OECD and beyond have implemented over the past 18 months. However, the recession has left deep scars that will be visible for many years to come. The crisis has lowered living standards and employment on a lasting basis, and at the same time, endangered the sustainability of public finances in many OECD countries. Yet there is still time to relieve the effects of these scars through appropriate policy action.

Governments have already started removing some of the emergency measures brought in to save the global economy from collapse. For a more positive economic outlook to take hold, policymakers should increasingly phase out some of these exceptional policy initiatives, while at the same time maintaining or reinforcing other measures, launching new reforms and resisting protectionist reactions in international trade and labour markets. Candidates for gradual removal include the exceptional government support to automotive and other industries, public funding for new infrastructure projects and crisis-related increases in unemployment benefits where these were already fairly high.

By contrast, areas where reform efforts could be strengthened include reductions in anti-competitive product market regulations to boost activity and job creation, increased use of price instruments in green growth policies and active labour market policies, which will need to cope better with the sizeable recent and ongoing rise in unemployment than they did in past downturns. It also makes sense to maintain recent tax support to private R&D and targeted labour tax cuts as long-term growth support measures, but only where these can be financed.

Indeed, restoring fiscal sustainability will be a daunting task for most OECD governments in the years ahead. Fulfilling this task, while protecting long-term growth, will require reaping effi ciency gains on spending, especially in the areas of education and health, and avoiding large increases in harmful labour and capital taxes. OECD countries have avoided the major structural policy mistakes of certain past crises, such as the protectionist spiral of the 1930s or the misguided labour market policies of the 1970s.

In fact, the 2010 edition of Going for Growth finds that, in line with last year’s recommendations, many of the measures taken in the areas of R&D, infrastructure, labour taxes and active labour market policies will help to contain the long-term damage of the crisis for welfare.

So far, so good. But there is no room for complacency. Our report’s in-depth assessment of progress over the past five years across the OECD shows that reforms have been more incremental than radical in nature and seldom address the thorniest issues. Nor is it at all clear that structural reform has accelerated since the start of the crisis, as policymakers have understandably focused on the most pressing macroeconomic issues, not least battling with deficits.

But with the nadir of the crisis now behind us, the time has come to move away from crisis management mode towards speeding up the recovery and laying the ground for a more sustainable and fairer economic future. In this spirit, Going for Growth highlights for each OECD country those policy priorities that we think would be most urgent to address at the current juncture to maintain decent standards of living.

Structural reform in financial, product and labour markets has to be part of the cure. This is fairly obvious for financial market regulation, whose past deficiencies have been a major force behind this crisis and where the crisis response has left new challenges in the form of moral hazard and weak competition. At fi rst glance, this may seem less obvious for product and labour market reforms. Indeed, with this crisis having shaken our thinking on financial market regulation, one might naturally wonder whether longstanding policy prescriptions for these other areas should be revisited as well. The broad qualified answer has to be no.

As dramatic as they have been, the crisis has not radically altered the large income per capita gaps that prevail across the OECD, which as a wealth of evidence shows, can be traced back to cross-country differences in education systems, labour market institutions, product market regulations or the design of tax and welfare systems, among a broad range of factors. In fact, the damage of the crisis on income levels and public budgets, and to some extent the need to address global current account imbalances, has if anything strengthened the case for reform.

This of course does not imply that only one road leads to Rome, and indeed different countries can, and often do, opt for different but still efficient trade-offs between growth, risk and equity objectives.

Given the centrality of financial markets to the origins of the crisis, regulators across the OECD need to step up ongoing efforts to strengthen financial market regulation. On this front, our recent analysis, which is summed up in Going for Growth, brings some good news: outside a few specific areas of regulation, there is no evidence of any conflict between improving banking-sector stability and competition objectives.

It should thus be possible to strengthen regulatory frameworks while preserving, if not enhancing, the beneficial effects of competition on access and prices in financial services. This is a very encouraging message and should be taken as a call for action, at a time when reform efforts may risk being watered down or even stalled.

There is also urgent need for action on competition, jobs and taxes. Reducing obstacles to entering new markets would stimulate both business and job creation. In the employment area, governments need to boost spending on training and job-search at this critical time while maintaining strong job-search incentives for the unemployed. Special efforts also need to be devoted to preventing vulnerable groups, such as older workers, youths, low earners and single mothers, from quitting the labour market altogether.

As for tax, some of the measures taken in response to the crisis could prove beneficial to long-term growth and should be left intact. For instance, tax credits and direct grants for R&D could help counter a slump in innovation and, if carefully focused, could promote green initiatives. But because the crisis has wreaked havoc with public finances, some taxes that were cut will need to be raised. To minimise the detrimental impact of future tax hikes, the composition of taxes should be shifted away from income and towards consumption and land.

With the crisis having revealed the disproportionate gains that high-income households have enjoyed in recent years, income distribution and equity issues, which have long been a major policy concern, have moved to centre stage. One key dimension of equity within our societies is intergenerational social mobility, which promotes equal opportunity for individuals and enhances growth by putting all of society’s human resources to their best use. In a number of OECD countries, there appears to be quite some room for enhancing intergenerational mobility at no cost or even at a benefit through education reform, including by increasing enrolment in early childhood education, avoiding early tracking of students and improving the social mix within schools.

For the first time, this year’s edition of Going for Growth looks beyond the OECD area at the long-term prospects and challenges for Brazil, China, India, Indonesia and South Africa. Taken together, these BIICS–major emerging markets with which the OECD has established a relationship of “enhanced engagement”–have been an important engine for world growth throughout this crisis, and they account for a growing share of global output. At the same time, notwithstanding major improvements in human capital that bode well for future productivity trends, our analysis highlights a number of policy areas where reform will be needed to sustain strong growth and catch up further with OECD living standards. With some variations in emphasis across the BIICS, challenges include moving towards more competition-friendly product market regulation, strengthening property rights and contract enforcement, deepening financial markets and adopting multifaceted strategies to reduce the size of informal sectors.

Going for Growth is an evolving exercise. It does not claim to have silver bullets for the crisis, but it does provide some guidance on the kind of reforms that would, if applied, not only bolster longterm growth, but also speed up the recovery and greatly reduce the risks of such a crisis happening again.

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